IRS Correspondence Audits

IRS Correspondence Audits ©2011
Robert E. McKenzie

Custom Search

1. IRS REORGANIZATION
IRS Reorganization
1.10 The IRS has divided the country into 7 areas. The Area Directors for collection and exam respectively are in different cities within each of those 7 areas. All Territory Managers also specialize in one discipline. The IRS has decided that specialization is a much more efficient method for collecting taxes and examining tax returns than the generalist approach used immediately after reorganization.
Overall Rates
1.20 As the overall audit rates for different income classes are shifting, the proportion of individual taxpayers who faced any kind of audit–either the more rigorous Area audits or the semi-automated Compliance Center audits–dropped to its lowest rate in modern history, just under one percent (0.49%) in 2001 and rose to over 1% in 2009.
Reduced Audit Levels
1.30 A factor has been the substantial decline in the size of the IRS. After a buildup during the Reagan years, a series of cut-backs agreed to by the Bush and Clinton administrations and by Congress means that in 2007 the full-time IRS staff was 30% smaller than it was in 1988. (By contrast, the FBI is today larger than at any time in its history.) With substantially fewer employees, the face-to-face Area audits essential for the examination of larger and more complex tax returns have plummeted. This is true for both individuals and corporations.
Face to Face vs. Compliance Center Audits
1.40 Individual taxpayers can face two kinds of IRS audit — the Area “face-to-face” audit or the semi-automated Compliance Center audit. While Area audits have long been a major focus of public concern, Compliance Center audits have become a significant component of the IRS’s enforcement arsenal. The result of Compliance Center audits on individual taxpayers is far from negligible.
Examination
1.50 The Examination Division administers an audit program involving the selection and examination of all types of federal tax returns to determine correct liabilities due from taxpayers. Examinations are conducted either through interviews or correspondence. Many audits are conducted via correspondence from Compliance Center Tax Examiners. Each Area Office has Tax Compliance Officers (TCO) and Revenue Agents (RA) assigned to conduct audits. The TCO’s are not accountants and are only required to have two semesters of accounting to qualify for the job. Revenue Agents in field audit are required to have at least 30 semester hours of accounting. The respective Compliance Officers and/or Revenue Agents are assigned to groups of 10 to 12 persons managed by a Group Manager. The Group Manager reports to a Territory Manager who will be in charge of four to five groups in an area. That Territory Manager reports directly to the Area Manager for Examination.

Types of Examinations
1.60 The IRS utilizes several different examination techniques to determine the accuracy of tax returns. At the Compliance Center, computers are utilized to verify the computations shown on each return. If it is determined that the computations are incorrect on a return, a notice is issued to the taxpayer adjusting the amount of taxes due on the return. This is a math error notice. The Compliance Centers also conduct correspondence audits on issues by initiating letters to taxpayers requiring verification of deductions and/or exemptions shown on a return. Office audits of simpler 1040 returns are conducted in local Area Offices. Field examinations are conducted by Revenue Agents of more complex 1040 returns and other types of tax returns.
Compliance Center Audits
1.70 Compliance Centers conduct most correspondence audits. Some of these audits are generated as a result of information return matches. When the Compliance Center receives 1099s and W-2′s, it matches them with a return. If there is an indication that not all income has been reported, a letter known as a CP-2000 will be issued to the taxpayer. This letter requests that the taxpayer explain why particular income items were not reported on his return. The taxpayer may request that the matter be transferred to a local Area Office for consideration. Compliance Centers also conduct audits of other items which can be easily explained via mail.
Mathematical Errors
1.80 Each return received by a Compliance Center is checked for mathematical errors. If there is an apparent mathematical error, the Compliance Center computer will issue a notice to the taxpayer that the amount due on the respective return has been corrected because of the error. That computer generated notice will note the reasons why the change has been made on the return. A notice is not a deficiency notice where it is based solely upon a mathematical or clerical error appearing on the return. The taxpayer has 60 days after the notice to file a request for abatement for the assessment.
Document Matches
1.90 Many IRS correspondence audits are the result of document matches. Most large providers of 1099s and W-2s are required to file electronically, via the internet. The remaining paper 1099s and W-2s are manually encoded into the IRS computers by its clerical personnel. Once the information from 1099s and W-2s is encoded into the IRS computers, the IRS is able to conduct a matching of the information documents with income tax returns. If such matches indicate certain 1099s and/or W-2s have been omitted from a taxpayer’s return, a CP-2000 notice is issued to the taxpayer requesting an explanation of the omission. If the taxpayer fails to fully respond to the notice, the IRS will issue an adjustment notice.
Correspondence Audits
1.100 The Compliance Center computers are programmed to select those returns with high DIF scores which reflect issues that could be easily resolved by mail. The computers select those returns which are appropriate for correspondence audits and each respective return is reviewed by either a Tax examiner or clerk. The returns are DIF screened and quality reviewed using technically proficient examination personnel who are experienced in DIF screening operations. Returns which have apparent examination issues other than those appropriate for correspondence audit are referred to the local Area Office. Some examples of the kinds of items which can be verified by correspondence are itemized deductions, such as interest, taxes, contributions, medical expenses, and simple miscellaneous deductions such as union dues and small tools. Issues other than itemized deductions may be examined if they are single matters which would not be appropriate for office audit or field examination.

Correspondence Audit Procedures
1.110 When a return has been selected for a correspondence audit, the IRS has developed a series of computer generated notices with respect to various issues on a tax return. Once a reviewer has determined an issue for examination, he will cause the computer to generate the appropriate notice for that issue. The IRS notice will grant the taxpayer 30 das to respond to the notice. The Taxpayer may request that the audit be transferred to his local Area Office.
Correspondence Audit Trends
1.120 The number of individual income tax returns examined has continuously increased since 2000. During fiscal year (FY) 2000, the IRS audited 617,765 such returns. By FY 2007, this figure more than doubled, with the IRS examining 1,384,563 individual returns. Examinations completed by correspondence accounted for 83 percent of all individual taxpayer audits, and IRS campus offices conducted slightly more than 71 percent of the correspondence examinations. Recently released FY 2008 statistics reflect a continuation of this trend.
For FY 2009, the IRS plans to maintain the current level of correspondence examinations by initiating 1,122,554 individual audits. These materials focus on the specific procedures and issues associated with correspondence examinations.
Routine Exams
1.130 Correspondence examinations are those that can be handled routinely through the mail4. Returns are selected that are deemed to have questionable deductions, expenses or credits. IRS uses data to identify returns with high potential for a tax adjustment, including third-party information or potentially inconsistent line items on the return. They also include referrals from Criminal Investigation and preparer/promoter actions.
Compliance Campuses
1.140 These audits originate at an IRS Compliance Campus and can involve both pre and post-refund situations. Pre-refund examinations aim to protect revenue by holding the refund during the audit process. This is done when there is a high risk of later collectability by releasing the refund, information from the return is verified as false through third-party contacts, or entries on the return are contradictory. Other issues are examined after the original return is processed.

Pre-refund Examination Illustration
IRS Notice, CP 75 – EIC Portion of Refund Delayed
Initiation of correspondence audit on EIC compliance
Purpose: We send a CP 75 to inform the recipient that the Earned Income Credit portion of their refund will be delayed.
Reason for Issuance: Since IRS may examine portions of the recipient’s tax return that could affect their Earned Income Credit (EIC), we’re delaying the portion of the refund related to EIC. This notice outlines areas of the return we may examine and explains what steps we will take next.
_____________________________
We’re Reviewing Your Tax Return and Delaying Part of Your Refund

Why We’re Reviewing Your Tax Return
We’re reviewing your tax return. This review is why we’ve delayed sending you the earned income credit (EIC) part of your refund. The information below explains why we’re reviewing your return and the information you need to send us so we can make the right decision about your taxes.
EIC Recertification – You must show you qualify for EIC because we denied your EIC during a prior year examination. You need to send us information to show you’ve met three tests to claim a qualifying child. The enclosed Form 886-H-EIC, Supporting Documents for Taxpayers Claiming EIC, explains the tests.
Schedule C – You must have earned income to claim the EIC. Please complete and send us the enclosed Form 11652, Questionnaire, Form 1040 Schedule C and Supporting Documentation, to help us determine if you have the right amount of earned income.
Two Year Ban – Based upon the information we have available, we propose that you should be restricted from receiving the earned income credit for the next two years. This two year ban is asserted for the reckless or intentional disregard of the rules and regulations regarding the earned income credit under Internal Revenue Code section 32(k)(l)(B)(ii).

What You Need To Do Now
To get the EIC you deserve, please send us the above information within 30 days from this letter’s date.
You can send us the information by mail, in the enclosed envelope, or by fax to {appropriate #} (not toll-free).
Fill in and send us the stub on the last page of this letter. We’ll use the stub to make sure your information gets to the right person and to make sure we can call you if we have any questions.
If you can’t get all your information to us in time, call us at the above number to discuss what you can do.

What We’ll Do Once We Hear from You
We’ll review the information you send us. If your information shows your return was correct, we won’t make any changes to your tax return and we’ll send you the EIC part of your refund. You won’t need to do anything else.
If your information doesn’t show your return was correct, we’ll send you a report of changes we plan to make to your tax return and explain the tax you will owe.
We’ll also explain your right to appeal if you disagree.
Please allow us at least 30 days to review your information. After our review, we’ll let you know by letter what we’re going to do and explain your appeal rights if we propose changes.
Any EIC refund you claimed will be delayed while we review your information.

What Happens If You Don’t Reply
If we don’t hear from you within 30 days, you will not receive the EIC part of your refund. We’ll send you a letter and a report disallowing the tax return items we’ve questioned. We’ll explain how you can appeal if you disagree.

How to Get Help
You can only receive your EIC by mailing or faxing us the information we’ve requested.
However, we’ve enclosed Publication 3498-A, The Examination Process, to help you understand this review and your appeal rights. It will explain your right to have someone help or represent you. Please visit our website at www.irs.gov/eitc to learn more about the examination process.
You can also call our toll-free number {appropriate #} with any questions you may have about this letter or the information we need.
Your local IRS office can provide free help. You can find your nearest IRS office listed in your local phone book or at www.irs.gov/localcontacts/index.html. If you have a significant hardship, you can contact the Taxpayer Advocate Service at {appropriate #} (toll-free).
A Low Income Taxpayer Clinic may be able to offer you free help. The enclosed Publication 4134, Low Income Taxpayer Clinic List, lists the clinics’ locations and their eligibility guidelines.
Follow These Steps
1. Read the enclosed forms and publications and call us if you have questions or need help.
2. Gather the information explained on the first page of this letter.
3. Make clear, readable copies of the information and keep the originals for your records.
4. Fill in your telephone numbers and the best time to call on the stub. (You can find the stub on the last page of this letter.)
5. You can send us your information in the enclosed envelope or you can use your own envelope. Be sure to enclose the stub. Send all information to us at the address on this letter.
6. You also can fax the stub with your documents to fax number {appropriate #} (not toll-free).

Remember:
If you can’t get all your information to us within the 30 days, call us at our toll-free number {appropriate #} to discuss what you need to do.

Enclosures:
Form 886-H-EIC, Supporting Documents for Taxpayers Claiming EIC
Publication 3498-A, The Examination Process
Publication 4134, Low Income Taxpayer Clinic List
Form 11642, Questionnaire, Form 1040 Schedule C
Return Envelope

Inventory Selection Walkthrough: Earned Income Credit
1.150 Third-party information is related against a tax return to determine the validity of dependent and EIC claims. For example, the Federal Case Registry (FCR) is accessed for information about custody orders for children receiving public assistance as well as those arising from private divorce cases. Social Security Administration is used to validate the SSN for the qualifying child and names of parents. Results of prior audits are used to project potential of an EIC disallowance. Once, scored, returns are ranked for selection.
If a return is selected, the EIC portion of the refund will be held. The non-EITC amount will be refunded to the taxpayer. A letter, as illustrated previously, will generate to alert the taxpayer that the refund is being held pending an examination. EIC cases are assigned to an examiner only when correspondence is received from the taxpayer. Cases with no responses are worked completely through an automated system.

Source: SB/SE Phone Forum 8/13/2008, Correspondence Audits
Per this chart, there are 42 days between the initial contact letter and the 30-day letter and audit report. Once the audit report is issued, a 45 day suspense period begins, followed by a notice generation process. 63 days after issuance of the 30-day letter, a Statutory Notice of Deficiency is mailed. Mailing of the notice begins a 105-day suspense period in anticipation of taxpayer filing a Tax Court petition within the 90 days allowed for response. If the taxpayer does not petition, after 105 days, the case is closed by default, the assessment becomes final, and the collection process begins.

Post-refund Correspondence Exam Process
1.160 There are two types of letters used to begin a correspondence examination. The initial contact letter (ICL) (often, Letter 566) is used to notify a taxpayer of the opening of an audit without proposing a balance due. A “combo” letter is sometimes used rather than the ICL. It includes an examination report with the notification of the audit. Such letters are used on issues where there is reasonable certainty of the potential liability.

Examples of issues addressed in single-issue audits using “Initial Contact Letters” are:
● Schedule A
● Employee business expenses
● Charitable contributions
● Schedule C expenses

Examples of issues addressed in “combo letters” cover:
● Self-Employment tax
● Alimony
● AMT

Examination Workflow
1.170 IRS makes extensive use of automation in this program. Time deadlines are automatically programmed into the system. Audit contacts with no-response are systemically advanced through the audit process. Receipt of mail (once processed as received) precludes subsequent notices from being issued. Examiners are told that telephone contact is encouraged and they are to use judgment when evaluating responses.

IRS Guidance to Responding to a Correspondence Examination Notice
● Review the tax return
● Read Form 886, which outlines what information is being requested
● Answer any questions on the attachments
● Provide a phone number where taxpayer or representative can be reached
● Respond by the due date
● Enclose the Response Page from the Examination notice
● Use the return envelope provided; use the complete address shown on the provided return envelope if a larger envelope is needed

Letter 566
1.170 IRS generally includes an information document request (IDR) with the initial letter contact, which indicates records that will be needed. Typically they involve requests for supporting documents such as canceled checks or some other written instruments. Organization and responding on-point to the IDR are keys to success. If all items are not verified to the satisfaction of the examiner, in rare cases an additional IDR may be issued. A written reply to the questions asked, along with copies of supporting documents, usually complete the examination. Once the taxpayer responds, the examiner will make a determination.

Letter 525 – General 30 Day Letter
This letter accompanies a report giving the taxpayer a computation of the proposed adjustments to their tax return. It informs them of the courses of action to take if they do not agree with the proposed adjustments. The letter explains that if they agree with the adjustment, to sign and return the agreement form. If they do not agree, they can submit a request for appeal/protest to the office/individual that sent the letter. The letter or referenced publications explain how to file a protest. Taxpayers need to file a protest within 30 days from the date of this letter in order to appeal the proposed adjustments with the Office of Appeals.
Typically Letter 525 is used as a second contact with taxpayers during the examination process. It is the cover letter that accompanies the proposed examination adjustments report. When IRS uses a “combo letter” approach to correspondence examinations, they issue Letter 525 or 566-B as the initial contact letter. IRS Believes combo letters significantly reduce the audit cycle and present the taxpayer with a clearer understanding of the proposed changes.


The total number of audits of individual returns increased in 2010. Those who earned less than $200,000 had about a 1 percent chance of being audited. Those with incomes of $200,000 and more had about a 3 percent chance of being audited.

Total Individual Returns

FY 2001 FY 2002 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010
Field 202,515 205,134 247,235 302,785 311,339 310,429 326,249 342,762
Corres-pond 529,241 538,747 968,073 981,165 1,073,224 1,081,152 1,099,639 1,238,632

Total
Exam 731,756
743,881
1,215,308
1,283,950
1,384,563
1,391,581
1,425,888
1,581,394

Cover-age 0.58% 0.57% 0.93% 0.97% 1.03% 1.01% 1.03% 1.11%

Income Under $200,000
FY 2006 FY 2007 FY 2008 FY 2009 FY 2010
Field 266,726 267,699 256,854 269,865 284,241
Correspondence 929,666 1,011,315 1,003,976 1,010,870 1,144,178
Total Examinations 1,196,392
1,279,014
1,260,830
1,280,735
1,428,419

Returns Filed in Prior year 128,875,395 130,600,177 133,407,479 133,924,956 137,892,685
Coverage 0.93% 0.98% 0.95% 0.96% 1.04%

Income $200,000 and Higher
FY 2006 FY 2007 FY 2008 FY 2009 FY 2010
Field 36,059 43,640 53,575 56,384 58,521
Correspondence 51,499 61,909 77,176 88,769 94,454
Total Examinations 87,558
105,549
130,751
145,153
152,975

Returns Filed in Prior CY* 3,400,435 3,942,702 4,442,156 5,024,714 4,930,420
Coverage 2.57% 2.68% 2.94% 2.89% 3.10%

Millionaires
Meanwhile, taxpayers with incomes of more than $1 million had a 8.36 percent chance of being audited, up from 6.42 percent the year before. The number of audits for millionaires increased to 32,494 from 21,874 in 2008. The ranks of millionaires decreased by nearly 50,000 taxpayers in 2010 to 388,763 taxpayers.

Income $1 Million and Higher
FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010
Field 5,857 7,166 9,459 12,259 12,233 15,730 16,509
Correspondence 3,719 5,669 4,728 10,941 9,641 12,619 15,985
Total Exams 9,576
12,835
14,187
23,200
21,874
28,349
32,494

Returns Filed in Prior 190,372 210,280 270,161 339,138 392,776 441,715 388,763
Coverage 5.03% 6.10% 5.25% 6.84% 5.57% 6.42% 8.36%

Type and size of return Returns filed in
Calendar Returns examined in Fiscal Year 2010 [1]
All returns Total % Field [3] Corres-
pondence
(1) (2) (3) (4) (5)
United States, total [4] 187,124,450 1,735,083 0.9 462,131 1,272,952
Taxable returns:
► Individual income tax returns, total 142,823,105 [6] 1,581,394 1.1 342,762 1,238,632
► Returns with total positive income under $200,000 [8]:
► Nonbusiness returns without Earned Income Tax Credit:
Without Schedules C, E, F, or Form 2106 80,254,935 363,424 0.5 34,682 328,742
With Schedule E or Form 2106 [10] 16,052,553 190,746 1.2 61,268 129,478
► Business returns without Earned Income Tax Credit:
Nonfarm business returns
Under $25,000 10,736,434 132,584 1.2 47,260 85,324
$25,000 under $100,000 3,136,694 79,389 2.5 47,784 31,605
$100,000 under $200,000 893,707 42,403 4.7 30,333 12,070
$200,000 or more 705,877 23,569 3.3 21,627 1,942
Farm returns 1,367,656 4,921 0.4 2,122 2,799
► Business and nonbusiness returns
Under $25,000 22,910,578 [13] 556,809 2.4 17,472 539,337
$25,000 or more 1,591,972 [13] 28,393 1.8 15,894 12,499
► Returns with total positive income of at least $200,000 and under $1,000,000 [8]:
Nonbusiness returns 3,109,116 78,859 2.5 21,043 57,816
Business returns 1,432,541 41,622 2.9 20,969 20,653
Nontaxable returns [22]:
► Partnership returns
3,423,583 12,406 0.4 8,300 4,106
► S corporation returns [23] 4,414,662 16,327 0.4 15,146 1,181
► Estate and trust returns [5] 1,063 [5] 165 898

Table 9b. Examination Coverage: Individual Income Tax Returns Examined, by Size of Adjusted Gross Income,
Fiscal Year 2010
Size of adjusted gross income Returns filed in Calendar
Year 2009 % Examination coverage
in FY
2010 %
All returns [4] 100.00 1.11
No adjusted gross income 2.11 3.19
$1 under $25,000 39.62 1.18
$25,000 under $50,000 23.96 0.73
$50,000 under $75,000 13.41 0.78
$75,000 under $100,000 8.21 0.64
$100,000 under $200,000 9.64 0.71
$200,000 under $500,000 2.41 1.92
$500,000 under $1,000,000 0.41 3.37
$1,000,000 under $5,000,000 0.20 6.67
$5,000,000 under $10,000,000 0.01 11.55
$10,000,000 or more 0.01 18.38

Table 17. Civil Penalties Assessed and Abated, by Type of Tax and Type of Penalty,
Fiscal Year 2010
[Money amounts are in thousands of dollars.]
Type of tax and type of penalty Civil penalties assessed Civil penalties abated [2]
Number Amount Number Amount
(1) (2) (3) (4)
Civil penalties, total 37,055,841 28,055,115 4,874,920 10,025,544
Individual income tax:
Civil penalties, total [3] 27,106,767 14,525,188 3,039,087 4,109,484
Accuracy [4] 469,321 1,069,785 58,107 241,645
Bad check 152,225 14,212 6,770 4,791
Delinquency 3,529,203 5,871,164 804,058 2,195,182
Estimated tax 7,412,249 1,617,298 263,299 267,794
Failure to pay 15,538,896 5,828,731 1,901,839 1,346,024
Fraud 2,218 123,458 236 48,255
Other [5] 2,655 539 4,778 5,794
Business income tax:
Civil penalties, total 1,145,931 1,770,628 263,261 776,088
Accuracy [4, 6] 3,640 334,558 146 47,625
Bad check [6] 1,826 164 111 137
Delinquency [6] 639,251 758,432 173,326 421,878
Estimated tax [6] 213,035 231,940 12,349 106,221
Failure to pay [6] 269,950 374,144 72,123 183,134
Fraud [6] 161 14,334 7 662
S corporation/partnership information [7] 18,022 54,685 1,607 8,611
Other [6] 46 2,371 3,592 7,819
Employment taxes:
Civil penalties, total [8] 7,838,423 5,778,753 1,376,063 2,477,757
Accuracy [4] 1,786 8,827 218 529
Bad check 33,613 2,199 1,476 194
Delinquency 1,646,392 1,461,043 292,063 524,462
Estimated tax 3,688 12,723 726 6,680
Failure to pay 4,135,675 1,176,674 672,498 316,886
Federal tax deposits 2,016,966 3,108,562 409,049 1,628,555
Fraud 290 8,137 28 445
Other 13 587 5 6

Portions Reprinted from

“REPRESENTING THE AUDITED TAXPAYER BEFORE THE IRS”
AND
REPRESENTATION BEFORE THE COLLECTION DIVISION OF
THE IRS
by
Robert E. McKenzie

WITH PERMISSION FROM
THOMSON WEST
Rochester, NY
All Rights Reserved
COPYRIGHT 2011

Comments are closed.